Appeal from the District Court of the United States for the Western district of Pennsylvania; Robert M. Gibson, judge.
Before BIGGS, JONES, and GOODRICH, Circuit Judges.
The question presented by the appeal at bar is whether the taxpayer, Keystone Mutual casualty Company, is entitled to the exemption from income taxes provided by Sections 101(11) of the Revenue Acts of 1936 and 1938, 49 Stat. 1648, 1674 and 52 Stat. 447, 481, 26 U.S.C.A. Int. Rev. Code, § 101(11).*fn1 The complaint arose under the Act of march 3, 1887, c. 359, §§ 1, 2, 24 Stat. 505, as amended, 28 U.S.C.A. § 41 (20).
On July 22, 1936, the appellant was chartered as a mutual casualty company under the laws of Pennsylvania. 1921, May 17, P.L. 682, Art. I, § 101 et seq. 40 P.S. Pa. § 361 et seq. All policy holders are members of the compnay, each member having one vote for each policy held by such member. All policy holders present at meetings in person or by proxy may vote on resolutions. The appellant has never had any stock or stockholders. The articles of incorporation provide that officers and directors must be selected from the membership; that is to say, from among the company's policy holders, and officers and directors have always been thus selected.
The premiums charged have been about 25% lower than those charged by the socalled "bureau" c ompanies and somewhat lower than those charged by other mutual companies in the same territory. The appellant reduced its rates for insurance in 1937, reduced them twice in 1939, and reduced them again in 1940.
Income for the years 1936, 1937 and 1938 is involved. The court below, making additional findings of fact at the request of the appellant found that in the year 1936 the appellant operated at a net loss of about $2,850, at a net loss for the year 1937 of approximately $23,000, and at a net gain in the year 1938 of approximately $17,700.
During the years 1936, 1937 and 1938 insuring of automobiles constituted over ninety percent of the appellant's business The appellant's founder was Nathaniel P. Kann who in July, 1936, was conducting an insurance agency. A large proportion of the signers of the petition for the appellant's charter were members of his office force. Kann deposited $10,000 as the capital required by the law of Pennsylvania, 1921, May 17, P.L. 682, Art. II, § 206, as amended 1937, July 1, P.L. 2528 § 1, 40 P.S. Pa. § 386, and he and all the other signers agreed that in case of necessity they would submit to an assessment equal to the amount of premiums paid. 1921, May 17, P.L. 682, Art. IV § 426, 40 P.S. Pa. § 611. By the beginning of 1938 the appellant had acquired a very substantial reserve, but the court below found as a fact that this reserve was not greater in amount than that approved by the Insurance Department of Pennsylvania. No returns of excess have been made by the appellant to its members. The excess, as was found by the court below, was added to reserve for the purpose of increasing the standard and credit of the company and to permit it in time to do business in nearby States which require larger reserves for a mutual company than does Pennsylvania.
At the end of its first two and a half years of existence the company increased Kann's salary and gave him a $10,000 demand note for his original capital deposit, plus $24,000 in so-called bonus notes. The payment of these notes, however, was conditioned on the appellant's surplus exceeding $100,000 plus the amount of the notes. The District Court found as a fact that the appellant had never paid premium rebates or any redundancy to its policyholders, and stated, "Since its organization the company has been dominated by Mr. N. P. Kann, who obtained sufficient proxies of policyholders to be in control of all meetings. At the annual meeting held April 27, 1939, one of those present recommended that the company's surplus be returned to the policyholders as a dividend. The recommendation was not adopted, being opposed by Mr. Kann, who was in control."
The Pennsylvania statute relating to the reserves of mutual insurance companies other than mutual life companies is 1921, May 17, P.L. 682, Art. VIII, § 807, 40 P.S. Pa. § 917, which provides: "A mutual insurance company * * * shall maintain unearned premium and other reserves separately, for each kind of insurance, upon the same basis as that required of domestic stock insurance companies transacting the same kind of insurance * * * . Any reserve for losses or claims based upon the premium income shall be computed upon the net premium income, after deducting any so-called dividend or premium returned or credited to the member. * * *" Obviously the Pennsylvania legislature contemplated that a mutual insurance company should return a portion of its earnings to its members if its earnings and reserves warranted such a course.
The district Court held that the appellant was not entitled to the exemption provided by the sections of the federal statutes referred to in this opinion and that such statutory provisions granting exemptions, were to be construed strictly. Referring to decisions construing the statutes under consideration or similar acts, the District Court stated, 44 F.Supp. 658: "The consensus of the opinions is that the section contemplates an association of individuals whose sole object is to obtain insurance for themselves at cost, and, if amounts greater than necessary cost had ben collected, that excess was to be returned to members in some form. The maintenance of a reasonable reserve is not prohibited, but it must be for the one purpose of paying losses and expenses, with ultimate return of excess to members. In other words, the association is for the benefit of the members, and not the members for the benefit of the association."
During the tax years now under consideration, the appellant borrowed $90,000 from its bank at 1 1/2% interest and bought a $100,000 Government bond with an interest rate of 2 3/4%. The appellant admits that this particular transaction was beyond the usual scope of the activities of a mutual company but contends that this was de minimis and that for this reason alone it should not be denied its exemption as a mutual company. Other facts, however, throwfurther light on the appellant's attitude toward its members. It decreased its indebtedness to the lending bank by about $40,000 in a comparatively short time. During 1938 it sold securities which it held and realized profits in excess of $13,000. The court below, however, laid emphasis upon this transaction and stated, id. 44 F.Supp. at page 659, "It is not the function of a mutual casualty company under the exemption statute, wise as the transaction may be, to borrow money and pay out gains therefrom to policyholders - who are entitled to proper returns from their premiums, but not to returns from moneys otherwise acquired by the company.", citing MacLaughlin v. Philadelphia Contributionship, etc., 3 Cir., 73 F.2d 582, 584.*fn2
The appellant cites the legislative history of the statutes and points out that the revenue Act of 126, 44 Stat. 40, § 231(11) 26 U.S.C.A. Int. Rev. Code § 101(11), was the first statute to contain the exact language set out in Section 101(11) of the Revenue Act of 1938, 52 Stat. 481. Section 101(11) of the Revenue Act of 1936, 49 Stat. 1648, is identical in language with the corresponding section of the Revenue Act of 1938. The appellant points out that Section 231(10) of the Revenue Act of 1924, 43 Stat. 282, 26 U.S.C.A. Int. Rev. Acts, page 38, exempted " * * * mutual * * * casualty * * * insurance companies * * * ; but only if 85 per centum or more of the income consists of amounts collected from members for the sole purpose of meeting losses and expenses; * * * ." It is correct, as the appellant points out, that the Revenue Act of 1926 removed the exemption of casualty insurance companies from the provisions of Section 231(10) and placed that exemption in Section 231(11), 44 Stat. 40, which contains no requirement that 85 per centum of the income be collected from members.
The Reports of the House Ways and Means Committee and the Senate Finance Committee (1939-1 (Part 2) Cumulative Bulletin 321, 349-350) state: "It so happens that in the case of insurance companies of a type covered by the new subdivision (11) of this Section the losses vary from year to year, and consequently in certain years the assessments collected are not used up in the payment of losses and expenses and no additional money is required to be collected for the payment of losses in the succeeding year." The appellant contends that the words quoted constituted recognition by Congress that money collected by way of premiums by an insurance company one year may be used by it to pay losses incurred upon policies written thereafter and the company still be entitled to exemption under the statutes. This legislative history does not indicate, however, that it was the intention of Congress that an insurance company claiming to be a mutual company may build up a large reserve as if it were an ordinary casualty company, meanwhile making no returns of premiums to members in accordance with the principle of ...